Understanding the differences between revocable and irrevocable trusts is key to making an informed decision about the best estate planning solution that is available to your family. Revocable and irrevocable trusts serve different purposes, the Law Offices of Mildred J. Michalczyk will briefly go over the major differences between the two types of trusts available to its clients.

1. Whether Ownership Transfers

As soon as assets are placed into an irrevocable trust, those assets cease to be the property of the Grantor: they become assets of the trust. Similarly to renting an apartment or leasing a vehicle, the assets are still available for use by the Grantor but the Grantor no longer maintains ownership over the assets. A correctly executed and properly prepared irrevocable trust can provide protection of assets from lawsuits filed by the Grantor’s creditors, as the assets have completely changed ownership. In contrast, when executing a revocable trust, the Grantor retains complete ownership of the property placed in the trust.

2. Estate Taxes

Since the Grantor no longer owns the assets once placed into a properly set-up irrevocable trust, assets placed into an irrevocable trust will not be included in calculations of property value for the purposes of calculating estate tax. In contrast, in a revocable trust wherein the Grantor still maintains ownership of the property, assets placed in the trust will be included in computations of property value for estate tax purposes.

3. How Taxes are Filed

Generally an irrevocable trust has its own tax identification number (EIN) and files a 1041 for the purposes of reporting taxable income to the IRS; it then either pays the tax itself, or passes the taxes on to the Grantor (or the Beneficiaries, if the Grantor is deceased) through the use of a Schedule K. The income declared on the Schedule K then passes on to the Grantor’s or Beneficiaries’ (if Grantor is deceased) 1040 tax return through the use of Schedule E. In contrast, with a revocable trust taxes are filed and paid on the Grantor’s 1040 tax return, because the Grantor personally owns the assets that are placed into the revocable trust.

4. Modification

An irrevocable trust generally cannot be altered, changed, amended, or revoked, even upon Court order, thus offering extensive asset protection. Within a revocable trust, the agreement may be altered or revoked at the Grantor’s discretion: this means assets placed into a revocable trust are still subject to judgments against the Grantor. While generally the term ‘irrevocable’ implies that the trust may not be amended under any circumstances, this is not always the case. If a special power of appointment is placed into the trust agreement, the Grantor might be given the power to modify the named beneficiaries at the Grantor’s discretion without affecting the benefits of the irrevocable trust.

5. Trustee

Within an irrevocable trust, the trustee is generally an independent third party chosen by the Grantor for the purposes of creating a fiduciary duty to protect the assets – family members as Trustee generally do not offer the same protection. The trustee has the duty of managing the assets within the trust, and is bound by its provisions; when a third party trustee is employed, it is apparent that the Trustee is exercising independent control of the trust assets. In contrast, in revocable trusts, the Grantor often serves the role of Trustee.

6. Medicaid

When assets are placed into an irrevocable trust five years ahead of the Grantor’s actual need, the Grantor ensures that assets are secured for the benefit of named beneficiaries. As long as five years have passed since the execution of the irecovable trust, an elderly Grantor may obtain Medicaid benefits when he or she moves into a nursing home. This is not the case in revocable trusts, where the Grantor retains ownership of the assets.

7. Asset Protection

Assets properly placed into irrevocable trusts no longer belong to the Grantor and as such, they are generally protected from claims brought forth by Grantor’s creditors, or other claimants, such as Medicaid, Medicare, or divorcing spouses. Medicaid generally requires an individual going to a nursing home to spend a majority of his or her own money before Medicaid benefits kick in, but irrevocable trusts have been used to circumvent this requirement. Assets are generally completely insulated and protected from legal claims brought against the Grantor. In contrast, with a revocable trust no asset protection is offered; as the Grantor still maintains full control and power over the assets, he or she is liable for legal claims against the assets.

Now that the Law Offices of Mildred J. Michalczyk has gone over the differences between revocable and irrevocable trusts, the purposes of each of these devices becomes clear. The primary purpose of a revocable trust is to avoid the probate process, thereby simplifying the transfer of assets to the beneficiaries and removing Probate Court from the process.  In contrast, the primary purpose of an irrevocable trust is to protect assets, it precludes assets placed in the trust from being seized because of claims against the Grantor, it also prevents entrusted assets from being included in asset valuation of the decedents at time of death, thereby protecting the beneficiaries from estate tax and the probate process.

Consulting a legal professional is advised before determining which estate planning tool is better for your family’s situation.